14.27 Economics and E-commerce
Exam 2
Fall 2012
You will have approximately 85 minutes in which to complete this exam. The exam
is out of 85 points to help you budget your time. Please keep answers concise.
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1. (28 points) Short Answer
a) Most search models, such as Diamond and Stahl, assume that the search costs
are exogenously determined. We learned in class, though, that firms can and
do take actions to make price search more difficult. Give three examples of
such actions. Can technologies available to e-retail firms make these
“obfuscation” techniques easier or cheaper to implement? Provide examples.
b) Instead of selling advertising on their search results pages in the standard
way---legions of executives negotiating rates with large advertisers and
posting prices for the small advertisers---Google decided to auction off all of
their “sponsored links.” They invented a new auction mechanism, a weighted
generalized second price auction. Describe two novel features of the
mechanism and how they contribute to its success.
c) Privacy advocates worry about “behavioral targeting,” where advertisers
obtain information about potential customers’ web browsing habits in order
to serve them more effective display ads during their time on the internet. If
privacy legislation prevented this type of customer tracking and, as a result,
rendered internet ads less effective, name three likely results.
d) Briefly describe the tax advantage enjoyed by mail-order businesses relative
to brick and mortar ones and how this tax-advantaged status would be
expected to have an impact on geographic distribution of mail order
businesses. What if the tax-advantaged status disappears?
2. (16 points) Essay
General merchandisers, such as Sears and Montgomery Ward, saw the popularity of
their mail order business peak in the 1920s. In the decades to follow, mail order
was ceded mostly to specialty retailers. E-retail has ushered in the reemergence of
mail order general merchandisers, such as Amazon. Why did general mail order
decline relative to brick and mortar initially and why might e-retail enjoy
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advantages over catalog retailers that will allow general merchandisers to survive
online? Please craft your answer as an essay but include specifics to make your
arguments.
3. (21 points)
Suppose a search engine wants to sell two advertising slots (call them slots 1 and 2)
for a particular keyword. The search engine does not know how many advertisers
might be willing to purchase the slots or what their valuations might be. In fact,
there are two advertisers (A and B) who know of each other and know their own
and each other’s valuations per click, VA and VB, where VA > VB. Suppose also that
the two advertisers’ ads are of equal quality and that the slots are differentiated by
click-through rates, C1 and C2, where C1 > C2. C1 and C2 are known to everyone. Each
advertiser can buy at most one slot.
a) The search engine first decides to run sequential auctions, auctioning off slot
2 first and then slot 1. How much revenue will it raise?
b) Then the search engine figures out that it might do better if it auctions the
two slots simultaneously, giving slot 1 to the highest bidder and slot 2 to the
second highest. Find an equilibrium where the search engine gets more
revenue than in the sequential auction.
c) How well would the search engine do relative to the answers in a) and b) if it
ran sequential auctions first auctioning slot 1 then slot 2?
4. (20 points)
A company offering cloud storage has performed some market research and
determined that its customers each have demand Q=25-P, where Q is the number of
gigabytes of storage and P is the annual price in dollars. The cost of providing the
storage is $5 per gigabyte per year.
a) What is the profit-maximizing price per gigabyte for the cloud storage
company?
Suppose, instead, that it found that its American customers have a different demand
than its European customers. In particular, customers who have made their
purchases from a European IP address each have demand Q=25-P, but customers
who have made their purchases from the US have demand Q=20-P.
b) Assuming the cloud storage company could distinguish between European
and US customers and offer a different price to the two groups, what would
its profit maximizing PE and PUS be?
c) Suppose some blocking software started being used that made distinguishing
between them impossible (but the company knew that approximately half of
their customers came from Europe and half from the US). Could the company
do better than offering the same per-gigabyte price to both groups?
Demonstrate or explain.
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14.27 Economics and E-Commerce
Fall 2014
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